ACCOUNTING AND THE
1 FINANCIAL STATEMENTS
DISCUSSION QUESTIONS
1. Accounting is an information system that identifies, measures, records, and communicates financial
information about a company's business activities to permit informed decisions by users of the
information. Accounting is often referred to as the language of business because it
communicates relevant and reliable information about economic activities of a company
that helps people make better decisions.
2. Accounting information is demanded (or needed) by decision-makers both inside and outside the
business to provide information about business activities and finances so that informed decisions
can be made. Six groups that create the demand for accounting information and their uses of
accounting information are described next:
(1) Managers use accounting information to help decide which actions to take, predict the
consequences of their actions, and evaluate the effectiveness of their past decisions.
They also use accounting information to control the operations of the company.
(2) Investors (owners) need accounting information about a business to evaluate the future
prospects of a business and to decide where to invest their money.
(3) Creditors (lenders) need accounting information to decide whether or not to lend money
(extend credit) to a business.
(4) Governments need accounting information about businesses to determine taxes owed by
businesses, to implement a variety of regulatory objectives, and to make national economic
policy decisions.
(5) Labor unions use accounting information when negotiating wage increases for its members.
(6) Financial analysts use accounting information when offering buy or sell recommendations to clients.
3. Financial accounting is the accounting information that satisfies the needs of external decision-
makers. Financial reporting (or disclosure) is the process of communicating financial
accounting information to those external decision-makers.
4. Data analytics is the process of analyzing data so that businesses can make decisions more efficiently.
The four types of analytics are descriptive—summarizes what has happened; diagnostic—explains
why things happened; predictive—attempt to predict what will happen in the future; and prescriptive—
recommends a possible course of action.
5. An accounting entity is a business that has an identity separate from that of its owners and
managers and for which accounting records are kept. There are three main forms that
accounting entities take: a sole proprietorship, a partnership, and a corporation.
6. A sole proprietorship is a business entity owned by one person. A partnership is a business entity
owned jointly by two or more individuals. The owner of a sole proprietorship and the partners in a
partnership are responsible for the debts of the
business. A corporation is a separate legal entity formed by one or more persons called
stockholder(s) . A corporation is legally separate from the affairs of its owners, which limits the
stockholders’ legal responsibility for the debt of the business to the amount that the stockholders
invested in the business. Corporate shareholders generally pay more taxes than owners of sole
proprietorships or partnerships. Although the combined number of sole proprietorships and
partnerships largely outnumbers the number of corporations, the majority of business in the
United States is conducted by corporations.
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© 2025 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part..
,CHAPTER 1 Accounting and the Financial Statements
7. The three main types of business activities are financing activities, investing activities, and
operating activities. Financing activities involve obtaining the funds necessary to begin and
operate a business. These funds come from either issuing stock or borrowing money. Investing
activities involve buying and selling assets that enable a corporation to operate. Operating
activities are the normal business activities that a company engages in as it conducts its
business. These activities involve selling products or services, purchasing inventory, collecting
amounts due from customers, and paying suppliers.
8. Assets are the economic resources (or economic benefits) that a business controls.
Liabilities are the creditors’ claims on the resources of a business. Stockholders’ equity
is the ownership claim on the resources of a business. Stockholders’ equity is considered a
residual interest in the assets of a business that remain after deducting the business’s liabilities.
9. Revenues are the increases in assets that result from the sale of products or services.
Expenses are the costs of assets used, or the liabilities created, in the operation of
the business. If revenues are greater than expenses, a business has earned net income. If
expenses are greater than revenues, a business has incurred a net loss.
10. The four primary financial statements are as follows:
(1) Balance sheet: A presentation of information about a company’s economic resources
(assets) and the claims against those resources by creditors and owners (liabilities and
stockholders’ equity) at a specific point in time.
(2) Income statement: A report on how well a company has performed
over a period of time.
(3) Retained earnings statement: A report on how much of the company’s income was
retained in the business and how much was distributed to owners over a period of time.
(4) Statement of cash flows: A report on the changes in a company’s cash during a period
of time. The statement of cash flows provides information about the company’s sources (inflows)
and uses (outflows) of cash.
11. There are many questions that can be answered based on each of the financial statements:
(1) Balance sheet:
a. What is the total amount of assets (economic resources) of a corporation? What is
the total amount of liabilities (claims against the resources) for a corporation?
b. How much equity do the owners of the corporation have in its assets?
c. Is the corporation able to pay its debts as they become due?
(2) Income statement:
a. How much revenue was earned last month? Last quarter? Last year?
b. What was the total amount of expenses incurred to earn that revenue?
c. How much better-off is the corporation at the end of the year than it was at the
beginning of the year?
d. Was the corporation profitable, and what are the prospects for the corporation’s
future profitability?
e. What are the prospects for the future growth of the corporation?
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© 2025 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 1 Accounting and the Financial Statements
(3) Retained earnings statement:
a. How much income was distributed in dividends by the corporation?
b. What amount of equity in the business has been generated internally?
(4) Statement of cash flows:
a. How much cash was taken in or paid out as a result of operations?
b. How much cash was invested in new equipment?
c. How much cash was used to pay off business debt?
12. Point-in-time measurement means as of a particular date. The balance sheet is a point-in-time
measurement. The period-of-time description applies to what has happened over a time interval.
The income statement is a period-of-time measurement that explains the business activities
between balance sheet dates. The statement of cash flows and the statement of retained
earnings are also period-of-time measurements.
13. The fundamental accounting equation is:
Assets = Liabilities + Stockholders’ Equity
The equation is significant because it means that the balance sheet must always balance. This
implies that what a company owns (its resources) must always be equal to the claims of its
creditors (liabilities) and investors (stockholders’ equity).
14. Each financial statement includes a heading that is comprised of (a) the name of the company,
(b) the title of the financial statement, and (c) the time period covered—either a point-in-time
measurement (an exact date) or a period-of-time description (e.g., a year ended in a specific
date).
15. Current assets are cash and other assets that are reasonably expected to be converted to cash
within 1 year or the operating cycle, whichever is longer. Current liabilities are obligations that
will be satisfied within 1 year or the operating cycle, whichever is longer.
Since current assets are presented separately from other assets, statement users can see if
the firm is likely to have enough resources available to meet its current liabilities as they become
due. If current assets were presented among other assets, such a determination would be difficult.
Current liabilities are separated from long-term liabilities because current liabilities will require
asset outflows (or replacement with another liability) much sooner than will long-term liabilities. If
all liabilities were presented together, financial statement users would have difficulty determining
the assets (economic resources) required in the near future to satisfy the current liabilities.
16. Current assets are generally listed on the balance sheet in order of liquidity or nearness to cash,
whereas current liabilities are usually listed in the order in which they will be paid.
17. The two main components of equity are contributed capital and retained earnings. Contributed
capital is increased by investments of new capital in a company by its owners (the issue of
common stock to stockholders). Retained earnings is the accumulated net income of a company
that has not been distributed to owners. Retained earnings is increased by net income and
decreased by net losses and dividends.
18. Net Income = Total Revenues – Total Expenses
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© 2025 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 1 Accounting and the Financial Statements
19. The single-step income statement format takes into account only two categories: total revenues
and total expenses. Total expenses are subtracted from total revenues in a single step to arrive at
net income. The multiple-step income statement organizes revenues and expenses into multiple
categories. The resulting subtotals (gross margin [gross profit], income from operations, and
net income) highlight important relationships between revenues and expenses that financial
statement users find useful.
20. A retained earnings statement summarizes and explains the changes in retained earnings
during an accounting period. Retained earnings is the income earned by the company but not
paid to the owners in the form of dividends. The retained earnings statement starts with the
balance in retained earnings at the beginning of the period. To this balance, add net income (or
subtract the net loss) obtained from the income statement. Next, subtract any dividends the
company declared during the period. The total is the retained earnings at the end of the period
that is reported on the balance sheet.
21. The statement of cash flows classifies cash flows into three categories: (1) cash flows from
operating activities, (2) cash flows from investing activities, and (3) cash flows from financing
activities. Cash flows from operating activities are the cash flows related to the normal operations
of the business in earning income, and these include cash sales and collections of accounts receivable
minus cash paid for goods, services, wages, salaries, and interest. Cash flows from investing
activities are cash flows related to the acquisition or sale of investments and long-term assets,
including cash received from the sales of property, plant, and equipment; investments; and other
long-lived assets minus the cash spent to purchase long-term assets. The cash flows from
investing activities by a healthy, growing business will often reflect an excess of
expenditures over receipts. Cash flows from financing activities are the cash flows related to
obtaining the capital of the company, including the cash contributed by owners and borrowed
from creditors minus amounts paid as dividends and repayments of liabilities.
22. The retained earnings statement describes the changes in retained earnings, a balance sheet
account, that occur between two balance sheet dates. One of the major sources of change in
retained earnings is the net income (or net loss) for the year, which is determined on the income
statement. The other major source of change in retained earnings is dividends, which are not
considered a part of income.
23. Examples of unethical behavior will differ from one student to another. One example is an
accountant who gives in to personal pressure to prepare financial statements that overstate the
income of the company by bending or violating generally accepted accounting principles.
Overstated income may lead decision-makers to make the wrong choices. Decision-makers
inside and outside the business must be able to rely on the financial information they receive to
make proper decisions. Therefore, ethical behavior by accountants is necessary. Acting ethically
is not always easy. However, because of the important role of accounting in society, accountants
are expected to maintain the highest level of ethical behavior.
24. The three elements of ESG reporting are environmental, social and governance. Examples of
environmental issues are carbon emissions, water stress, biodiversity, pollution, and energy efficiency.
Examples of social issues include health and safety; labor management; diversity, equity and inclusion;
and data privacy/security. Examples of governance issues include ethics, tax transparency,
board diversity, executive pay.
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© 2025 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
1 FINANCIAL STATEMENTS
DISCUSSION QUESTIONS
1. Accounting is an information system that identifies, measures, records, and communicates financial
information about a company's business activities to permit informed decisions by users of the
information. Accounting is often referred to as the language of business because it
communicates relevant and reliable information about economic activities of a company
that helps people make better decisions.
2. Accounting information is demanded (or needed) by decision-makers both inside and outside the
business to provide information about business activities and finances so that informed decisions
can be made. Six groups that create the demand for accounting information and their uses of
accounting information are described next:
(1) Managers use accounting information to help decide which actions to take, predict the
consequences of their actions, and evaluate the effectiveness of their past decisions.
They also use accounting information to control the operations of the company.
(2) Investors (owners) need accounting information about a business to evaluate the future
prospects of a business and to decide where to invest their money.
(3) Creditors (lenders) need accounting information to decide whether or not to lend money
(extend credit) to a business.
(4) Governments need accounting information about businesses to determine taxes owed by
businesses, to implement a variety of regulatory objectives, and to make national economic
policy decisions.
(5) Labor unions use accounting information when negotiating wage increases for its members.
(6) Financial analysts use accounting information when offering buy or sell recommendations to clients.
3. Financial accounting is the accounting information that satisfies the needs of external decision-
makers. Financial reporting (or disclosure) is the process of communicating financial
accounting information to those external decision-makers.
4. Data analytics is the process of analyzing data so that businesses can make decisions more efficiently.
The four types of analytics are descriptive—summarizes what has happened; diagnostic—explains
why things happened; predictive—attempt to predict what will happen in the future; and prescriptive—
recommends a possible course of action.
5. An accounting entity is a business that has an identity separate from that of its owners and
managers and for which accounting records are kept. There are three main forms that
accounting entities take: a sole proprietorship, a partnership, and a corporation.
6. A sole proprietorship is a business entity owned by one person. A partnership is a business entity
owned jointly by two or more individuals. The owner of a sole proprietorship and the partners in a
partnership are responsible for the debts of the
business. A corporation is a separate legal entity formed by one or more persons called
stockholder(s) . A corporation is legally separate from the affairs of its owners, which limits the
stockholders’ legal responsibility for the debt of the business to the amount that the stockholders
invested in the business. Corporate shareholders generally pay more taxes than owners of sole
proprietorships or partnerships. Although the combined number of sole proprietorships and
partnerships largely outnumbers the number of corporations, the majority of business in the
United States is conducted by corporations.
1-1
© 2025 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part..
,CHAPTER 1 Accounting and the Financial Statements
7. The three main types of business activities are financing activities, investing activities, and
operating activities. Financing activities involve obtaining the funds necessary to begin and
operate a business. These funds come from either issuing stock or borrowing money. Investing
activities involve buying and selling assets that enable a corporation to operate. Operating
activities are the normal business activities that a company engages in as it conducts its
business. These activities involve selling products or services, purchasing inventory, collecting
amounts due from customers, and paying suppliers.
8. Assets are the economic resources (or economic benefits) that a business controls.
Liabilities are the creditors’ claims on the resources of a business. Stockholders’ equity
is the ownership claim on the resources of a business. Stockholders’ equity is considered a
residual interest in the assets of a business that remain after deducting the business’s liabilities.
9. Revenues are the increases in assets that result from the sale of products or services.
Expenses are the costs of assets used, or the liabilities created, in the operation of
the business. If revenues are greater than expenses, a business has earned net income. If
expenses are greater than revenues, a business has incurred a net loss.
10. The four primary financial statements are as follows:
(1) Balance sheet: A presentation of information about a company’s economic resources
(assets) and the claims against those resources by creditors and owners (liabilities and
stockholders’ equity) at a specific point in time.
(2) Income statement: A report on how well a company has performed
over a period of time.
(3) Retained earnings statement: A report on how much of the company’s income was
retained in the business and how much was distributed to owners over a period of time.
(4) Statement of cash flows: A report on the changes in a company’s cash during a period
of time. The statement of cash flows provides information about the company’s sources (inflows)
and uses (outflows) of cash.
11. There are many questions that can be answered based on each of the financial statements:
(1) Balance sheet:
a. What is the total amount of assets (economic resources) of a corporation? What is
the total amount of liabilities (claims against the resources) for a corporation?
b. How much equity do the owners of the corporation have in its assets?
c. Is the corporation able to pay its debts as they become due?
(2) Income statement:
a. How much revenue was earned last month? Last quarter? Last year?
b. What was the total amount of expenses incurred to earn that revenue?
c. How much better-off is the corporation at the end of the year than it was at the
beginning of the year?
d. Was the corporation profitable, and what are the prospects for the corporation’s
future profitability?
e. What are the prospects for the future growth of the corporation?
1-2
© 2025 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 1 Accounting and the Financial Statements
(3) Retained earnings statement:
a. How much income was distributed in dividends by the corporation?
b. What amount of equity in the business has been generated internally?
(4) Statement of cash flows:
a. How much cash was taken in or paid out as a result of operations?
b. How much cash was invested in new equipment?
c. How much cash was used to pay off business debt?
12. Point-in-time measurement means as of a particular date. The balance sheet is a point-in-time
measurement. The period-of-time description applies to what has happened over a time interval.
The income statement is a period-of-time measurement that explains the business activities
between balance sheet dates. The statement of cash flows and the statement of retained
earnings are also period-of-time measurements.
13. The fundamental accounting equation is:
Assets = Liabilities + Stockholders’ Equity
The equation is significant because it means that the balance sheet must always balance. This
implies that what a company owns (its resources) must always be equal to the claims of its
creditors (liabilities) and investors (stockholders’ equity).
14. Each financial statement includes a heading that is comprised of (a) the name of the company,
(b) the title of the financial statement, and (c) the time period covered—either a point-in-time
measurement (an exact date) or a period-of-time description (e.g., a year ended in a specific
date).
15. Current assets are cash and other assets that are reasonably expected to be converted to cash
within 1 year or the operating cycle, whichever is longer. Current liabilities are obligations that
will be satisfied within 1 year or the operating cycle, whichever is longer.
Since current assets are presented separately from other assets, statement users can see if
the firm is likely to have enough resources available to meet its current liabilities as they become
due. If current assets were presented among other assets, such a determination would be difficult.
Current liabilities are separated from long-term liabilities because current liabilities will require
asset outflows (or replacement with another liability) much sooner than will long-term liabilities. If
all liabilities were presented together, financial statement users would have difficulty determining
the assets (economic resources) required in the near future to satisfy the current liabilities.
16. Current assets are generally listed on the balance sheet in order of liquidity or nearness to cash,
whereas current liabilities are usually listed in the order in which they will be paid.
17. The two main components of equity are contributed capital and retained earnings. Contributed
capital is increased by investments of new capital in a company by its owners (the issue of
common stock to stockholders). Retained earnings is the accumulated net income of a company
that has not been distributed to owners. Retained earnings is increased by net income and
decreased by net losses and dividends.
18. Net Income = Total Revenues – Total Expenses
1-3
© 2025 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 1 Accounting and the Financial Statements
19. The single-step income statement format takes into account only two categories: total revenues
and total expenses. Total expenses are subtracted from total revenues in a single step to arrive at
net income. The multiple-step income statement organizes revenues and expenses into multiple
categories. The resulting subtotals (gross margin [gross profit], income from operations, and
net income) highlight important relationships between revenues and expenses that financial
statement users find useful.
20. A retained earnings statement summarizes and explains the changes in retained earnings
during an accounting period. Retained earnings is the income earned by the company but not
paid to the owners in the form of dividends. The retained earnings statement starts with the
balance in retained earnings at the beginning of the period. To this balance, add net income (or
subtract the net loss) obtained from the income statement. Next, subtract any dividends the
company declared during the period. The total is the retained earnings at the end of the period
that is reported on the balance sheet.
21. The statement of cash flows classifies cash flows into three categories: (1) cash flows from
operating activities, (2) cash flows from investing activities, and (3) cash flows from financing
activities. Cash flows from operating activities are the cash flows related to the normal operations
of the business in earning income, and these include cash sales and collections of accounts receivable
minus cash paid for goods, services, wages, salaries, and interest. Cash flows from investing
activities are cash flows related to the acquisition or sale of investments and long-term assets,
including cash received from the sales of property, plant, and equipment; investments; and other
long-lived assets minus the cash spent to purchase long-term assets. The cash flows from
investing activities by a healthy, growing business will often reflect an excess of
expenditures over receipts. Cash flows from financing activities are the cash flows related to
obtaining the capital of the company, including the cash contributed by owners and borrowed
from creditors minus amounts paid as dividends and repayments of liabilities.
22. The retained earnings statement describes the changes in retained earnings, a balance sheet
account, that occur between two balance sheet dates. One of the major sources of change in
retained earnings is the net income (or net loss) for the year, which is determined on the income
statement. The other major source of change in retained earnings is dividends, which are not
considered a part of income.
23. Examples of unethical behavior will differ from one student to another. One example is an
accountant who gives in to personal pressure to prepare financial statements that overstate the
income of the company by bending or violating generally accepted accounting principles.
Overstated income may lead decision-makers to make the wrong choices. Decision-makers
inside and outside the business must be able to rely on the financial information they receive to
make proper decisions. Therefore, ethical behavior by accountants is necessary. Acting ethically
is not always easy. However, because of the important role of accounting in society, accountants
are expected to maintain the highest level of ethical behavior.
24. The three elements of ESG reporting are environmental, social and governance. Examples of
environmental issues are carbon emissions, water stress, biodiversity, pollution, and energy efficiency.
Examples of social issues include health and safety; labor management; diversity, equity and inclusion;
and data privacy/security. Examples of governance issues include ethics, tax transparency,
board diversity, executive pay.
1-4
© 2025 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
